Tuesday, November 3, 2009

I've been pointing to this topic (inside pharma) for months -- that very few financial reporters, and people, more generally, understand how much public company CEOs are given, once they depart the chief's seat. Reuters has a piece out this morning, discussing the pension component of it, across the Fortune 500. Per Reuters:

. . . .Pensions rose as a result of generous formulas and some little-scrutinized techniques, such as changes in age or interest rates used in calculations, the paper said, citing an analysis of filings from 340 Standard & Poor's 500 companies. . . .

And with the public outraged over lavish pay and big bonuses, the Journal on its website said pensions rose even as stock prices dropped by an average of 37 percent last year.

The chief executive of Merck & Co saw his pension benefit rise by nearly $10 million to $21.7 million last year. . . .

That's a doubling of his pension benefit.

Of course, the pension is only one small part of the overall post-employment pay any public company pharma CEO will receive. It is time to refresh the tutorial on CEO Hassan's departure package, I think. SO. . . here goes:

Lately, Schering-Plough's SEC filings have recited that "stock options granted on or after January 1, 2008" -- will not automatically vest on a Change of Control. That will be true for most pigs -- but CEO Fred Hassan is unlike most pigs. . . .

That is, it may be true as to other executives, but CEO Hassan negotiated "special grandfathering" of stock options, and other forms of equity compensation, for himself, and himself alone, in the event of a Change of Control, back in 2003, when he signed on -- here's his full employment agreement (the below is from Section 3(j) -- on page 4):

. . . .(j) DURING CHANGE OF CONTROL PERIOD

Without limiting the generality of the foregoing, during a Change of Control Period, the incentive, savings and retirement benefit opportunities (measured with respect to both regular and special incentive opportunities, to the extent, if any, that such distinction is applicable) and the other benefits provided to the Executive pursuant to Sections 3(d), (e), (f), (g), (h) and (i) shall in no event be less than the most favorable such opportunities and benefits provided to the Executive by the Company and its affiliates at any time during the 120-day period immediately preceding the Change of Control Date. In addition, notwithstanding anything herein or in the 2002 Plan to the contrary, upon the Change of Control Date, the Shares and the Options shall immediately vest in full, and the Options shall remain exercisable for the remainder of their stated term. . . .

That last bit nullifies any later action taken by the Board or Compensation Committee to limit the immediate, and full-vesting -- should a Change of Control occur, at least as to CEO Hassan.

And when the Merck transaction closes, that is exactly what Fred Hassan will say: all options -- including those granted on May 1, 2009 -- even after the announcement of the proposed merger -- must vest in full as to Hassan, and Hassan alone.

But that's just small potatoes, compared to the equity portions: Mr. Hassan has various option grants of 1,100,000 shares (at $18.20), 220,000 shares (at $20.70), 880,000 shares (at $20.70), 200,000 shares (at $19.23), 800,000 shares (at $19.23), 167,200 shares (at $18.85), 668,800 shares (at $18.85) and 868,300 shares (at $22.91). So, all of these are exercisable at various prices between $18.20 and $22.91 per share. [I have dropped from the tally, the options that aren't likely to be in the money: they are 236,000 shares, and 944,000 shares, each exercisable at $31.57 -- but do not forget about these, if by some miracle, Schering-Plough trades into the $31.60 range by merger time.]

Don't forget -- he has his 900,000 share option mega-grant from early 2004 -- exercisable at $17.34.

He also has the 2003-era 200,000 deferred stock units, and the February 27, 2009 deferred stock unit grant of 195,610 shares -- free and clear. [So the jet just got gilded!]

Finally -- he has his "all other performance based" stock units covering 672,714 shares -- if just the target amounts are paid out in 2009, and early 2010. Now, to calculate -- [I advise making an Linux spreadsheet!] on the options, it is simply a matter of subtracting assumed NYSE market prices, from exercise prices -- and multiplying by numbers of shares -- to reach his potential gain, at any given NYSE quoted stock price. Similarly, on outright share-grants, one multiplies the full NYSE stock price, times the total number of shares -- all of those share-gains are his to keep. Simple -- and simply dizzying -- given the size of the numbers, and the endless parade of serial grants.

So, tallying up just the incremental effects -- CEO Hassan's ultimate pay-out will rise by over $7.74 million -- for every dollar over $22.91 that Schering-Plough's common stock rises, in NYSE trading, as of the reverse-merger date (click image to enlarge -- as if you'd need to!):

By my reckoning, if the merger were to close tonight, at $28.20 -- Schering-Plough's NYSE intra-day common stock quote -- Mr. Hassan would walk away with a grand total of $174.97 million!

Now, on top of all of this, remember, the company must pay his taxes -- must gross him up -- should he be hit with any so-called IRS Section 280G "excessive (non-performance based) compensation" taxes. I cannot accurately model the size of that gross-up, in any detail -- but it could add an additional 30 percent to his all-in expense to the company. If the tax gross-up clauses were to be triggered, his compensation costs would likely be north of $200 million (as the company accrues, and pays, the compensation -- and the taxes on it).

Astonishing, no? I think so. [Original version was published in April of 2009.]

Only if a court of final jurisdiction declares his conduct to be "willful misconduct", or if he is "convicted of a FELONY, invloving moral turpitude", thus:

". . . .For purposes of this Agreement, "Cause" shall mean (i) repeated material violations by the Executive of the Executive's duties under Section 2 of this Agreement (other than as a result of incapacity due to physical or mental illness or injury) which violations (A) are demonstrably willful and deliberate on the Executive's part, and (B) are not remedied in a reasonable period of time after receipt of written notice from the Board specifying such violations, (ii) willful misconduct by the Executive in thecourse of performing his duties under Section 2 of this Agreement that results, or could reasonably be expected to result, in material harm to the business or reputation of the Company, or (iii) the Executive's conviction of (or plea of nolo contendere to) a felony involving moral turpitude. . . .

Any determination of "Cause" pursuant to this Section 4(b)(i) shall not be effective until there shall have been delivered to the Executive a copy of a resolution duly adopted by the affirmative vote of a majority of the entire membership of the Board (other than the Executive) at a meeting of the Board called and held for such purpose (after reasonable prior notice is provided to the Executive and the Executive is given an opportunity, together with counsel, to be heard before the Board), finding that, in the good faith opinion of the Board, the Executive has committed the violations described at Section 4(b)(i) and specifying the particulars thereof in detail, provided, however that during a Change of Control Period the affirmative vote must be bynot less than three-quarters of the entire membership of the Board (other than the Executive). . . ."

As a post-script, Salmon, I should note that CEO Hassan's employment agreement is certainly the most-aggressive I've ever seen, in any public pharma setting.

It is very aggressive, even when compared to other public "Turnaround CEO" scenarios (theoretically the guise under which he was retained).

It flirts dangerously, I think, with the edge of the envelope -- the edge being how much may a board of directors GIVE AWAY to an executive, they essentially cannot hold accountable -- while still saying with a straight face, that they haven't violated their fiduciary duties (to the shareholders) by signing such a one-sided contract.

Senator Grassley's Concern

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FDA Drug Facts

CEO Fred Hassan

The Condor. . . .

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